After much anticipation, the new Liberal government today tabled Budget 2016. Being the first budget of the government's mandate, Budget 2016 unveiled several significant tax changes that will impact individuals and businesses across Canada. The following is a summary of the highlights of the principal business income tax and international tax measures and some of the significant personal income tax measures contained in Budget 2016.
Access our Webinar: Insights and business impact of the Canadian Federal Budget 2016 on Wednesday, March 23, 2016. Check our website in the coming days for additional updates including commentary on income tax measures that are expected to impact individuals.
A. Business tax changes
Tax Support for Clean Energy
Budget 2016 proposes to generally allow electric vehicle charging stations to qualify for accelerated capital cost allowance (CCA) rates of 30% and 50% on a declining-balance basis. In addition, the range of property qualifying for such accelerated CCA rates will be expanded to include certain short- and long-term storage equipment that is ancillary to eligible generation equipment as well as certain stand-alone electrical energy storage property. These measures will apply in respect of property acquired for use on or after March 22, 2016, that has not been used or acquired for use prior to that date.
Emissions Trading Regimes
Budget 2016 proposes to clarify the tax treatment of emissions allowances of regulated emitters and to eliminate the double taxation of certain free allowances included in income as government assistance. Specifically, emissions allowances will be treated as inventory for all taxpayers, but the “lower of cost and market” valuation method will not be available. This measure will apply to emissions allowances acquired in taxation years beginning after 2016. It will also apply on an elective basis in respect of emissions allowances acquired in taxation years ending after 2012.
Small Business Tax Rates
Budget 2016 proposes that reductions in the small business tax rate currently legislated for 2017, 2018, and 2019 be reversed. Accordingly, the small business tax rate will remain at 10.5% after 2016 and the current gross-up factor and dividend tax credit rate applicable to non-eligible dividends will be maintained to preserve integrated tax rates.
Multiplication of the Small Business Deduction
Budget 2016 proposes changes to the small business deduction rules to address concerns about partnership and corporate structures that multiply access to the small business deduction by circumventing the application of certain rules. Subject to certain exceptions, Budget 2016 proposes to extend existing rules that limit access to the small business deduction to apply to certain structures in which a particular private corporation provides services or property (directly or indirectly) to:
(i) a partnership where the particular corporation, or a shareholder of the particular corporation, is a member of the partnership or does not deal at arm's length with a member of the partnership; or
(ii) another private corporation where the particular corporation, one of the shareholders of the particular corporation or a person who does not deal at arm's length with such a shareholder has a direct or indirect interest in the other corporation.
Budget 2016 also proposes certain amendments to prevent private corporations from misusing existing tax rules to multiply their entitlement to the small business deduction. These proposals will apply for taxation years that begin on or after March 22, 2016.
Consultation on Active Versus Investment Business
Budget 2016 announced that the government has completed a review of the circumstances in which income from a business, the principal purpose of which is to earn income from property, should qualify as active business income and therefore potentially be eligible for the small business deduction. Budget 2016 confirms that the government is not proposing any modification to those rules at this time.
Debt Parking to Avoid Foreign Exchange Gains
Budget 2016 proposes to introduce rules that will cause certain debtors to realize accrued foreign exchange gains on foreign currency debt obligations that are owed to arm’s length creditors where such debt obligations are acquired by a person not dealing at arm’s length with (or that has a significant interest in) the debtor. Budget 2016 indicates that relief from these rules will be provided for certain financially distressed debtors. Additionally, Budget 2016 proposes that exceptions will be made for certain bona fide commercial transactions.
Valuation of Derivatives
Currently a taxpayer’s interest in certain derivatives on income account can be treated as inventory that can be valued at the lower of original cost and fair market value, such that declines in value can be deducted before realization. Budget 2016 contains a proposal that will deem a taxpayer’s property that is a swap agreement, a forward purchase or sale agreement, a forward rate agreement, an option agreement or a similar agreement not to be inventory of the taxpayer for purposes of these inventory valuation rules. A companion rule will also prevent a taxpayer from writing down its derivatives to the lesser of cost and fair market value under general principles for income computation for tax purposes. This proposal will apply for derivatives entered into on or after March 22, 2016.
Eligible Capital Property
Budget 2016 proposes to repeal the existing eligible capital property (ECP) regime and replace it with a new CCA class (Class 14.1). This new class will have a 100% inclusion rate and a 5% deduction rate on a declining-balance basis. Budget 2016 proposes to calculate and transfer existing cumulative eligible capital (CEC) pool balances to the new CCA class as of January 1, 2017. For expenditures incurred before January 1, 2017, the depreciation rate will be 7% for the first ten years. Budget 2016 also contained transition rules, including special transition rules for small businesses.
Back-to-Back Loan Rules
Budget 2016 proposes to expand the scope of the existing shareholder loan rules to include back-to-back loan arrangements, such that a shareholder of a Canadian-resident corporation may have certain amounts included in its income (or be subject to Canadian withholding tax) where such shareholder owes amounts to an intermediary in the context of a back-to-back loan arrangement.
Budget 2016 also appears to broaden the scope of back-to-back arrangements and indicates that under proposed rules, “A back-to-back arrangement will comprise all the arrangements that are sufficiently connected to the arrangement under which a Canadian resident makes a cross-border payment of interest or royalties to an intermediary.”
B. International tax changes
Base Erosion and Profit Shifting
Canada has been an active participant in the “BEPS Action Plan,” a project of the Organisation for Economic Co-operation and Development (OECD) and the G-20. Base Erosion and Profit Shifting (BEPS) refers to tax planning strategies that exploit gaps and mismatches in national tax laws to shift profits to low- or no-tax locations. Budget 2016 announced that the government plans to act on the following recommendations from the OECD BEPS project:
- Introduction of Country-by-Country Reporting: Budget 2016 proposes to require country-by-country reporting for Canadian multinational enterprises with total annual consolidated group revenue of 750 million euros or more. This reporting would be due within one year of the end of the fiscal year to which the report relates with a view that the first exchanges between jurisdictions of country-by-country reports would occur by June 2018. Before any information is exchanged with another jurisdiction, the Canada Revenue Agency (CRA) will formalize an exchange arrangement with the other jurisdiction and will ensure that it has appropriate safeguards in place to protect the confidentiality of the reports. Draft legislative proposals to implement these rules will be released for comment in the coming months. Consistent with the BEPS project recommendations, country-by-country reporting will be required for taxation years that begin after 2015.
- Revised Transfer Pricing Guidance: The recommendations from the BEPS project include revisions to the OECD's Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrators, which provide guidance on the application of the arm's length principle. The revisions provide an improved interpretation of the arm's length principle and are intended to better align the profits of a multinational enterprise with the economic activities generating those profits. The government’s view is the revised transfer pricing guidelines are generally consistent with the CRA’s current interpretation and application of the arm’s length principle; therefore, current practices in Canada in this regard are not expected to change significantly. The CRA will not be adjusting its administrative practices relating to “low value-adding” services and “risk-free and risk-adjusted returns for minimally functional entities” (often referred to as “cash boxes”) until the BEPS project follow-up work in these areas is complete.
- Treaty Abuse: The BEPS project identifies treaty abuse, and in particular treaty shopping, as one of the most important sources of BEPS concerns. The BEPS treaty abuse minimum standard requires countries to include in their tax treaties an express statement that their common intention is to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance, including treaty shopping arrangements. Budget 2016 confirms the government’s commitment to address treaty abuse in accordance with the minimum standard. Canada currently has one tax treaty that has adopted a limitation-on-benefits approach as well as several tax treaties that have adopted a limited principal purpose test. Going forward, the government will consider either minimum standard approach, depending on the particular circumstances and discussions with Canada’s tax treaty partners. Budget 2016 also indicates that Canada’s tax treaties may be amended to include a treaty anti-abuse rule through bilateral negotiations, a multilateral instrument that will be developed in 2016, or a combination of the two.
- Spontaneous Exchange of Tax Rulings: Budget 2016 confirms the government’s intention to implement the BEPS minimum standard for the spontaneous exchange of certain tax rulings that could give rise to BEPS concerns. The CRA will commence exchanging tax rulings in 2016 with other jurisdictions that have committed to the minimum standard.
Budget 2016 also confirmed that the government is continuing to examine the other recommendations contained in the BEPS project final reports and confirmed that Canada is committed to the BEPS project and will continue to work with the international community to ensure a coherent and consistent response to BEPS.
Cross-Border Surplus Stripping
Currently, the Income Tax Act (Canada) (the Act) contains “anti-surplus-stripping” rules that generally prevent a non-resident shareholder of a Canadian corporation from entering into transactions to distribute free of tax a Canadian corporation’s retained earnings (or “surplus”) in excess of the paid-up capital of its shares or to artificially increase the paid-up capital of the shares. When applicable, the anti-surplus-stripping rules result in a deemed dividend to the non-resident or a suppression of the paid-up capital of the shares that would otherwise have been increased as a result of the transaction.
There is an existing exception to the anti-surplus-stripping rules that applies in certain situations where a non-resident corporation is "sandwiched" between two Canadian corporations. However, transactions have been undertaken that the government views as having inappropriately used this particular exception. While certain of these transactions are currently being challenged under existing provisions and the general anti-avoidance rule, Budget 2016 proposes to amend the exception to provide clarity and ensure that it applies as intended to prohibit surplus stripping. This measure will apply in respect of dispositions occurring on or after March 22, 2016.
Extension of Back-to-Back Rules
The “back-to-back” loan rules contained in the Act aim to prevent taxpayers from interposing an intermediary in order to avoid the application of rules that would normally apply if a loan were made directly between the two taxpayers. Budget 2016 proposes to expand the scope of those rules as described below.
- Extension to royalties: Budget 2006 proposes to extend back-to-back rules to rents, royalties or similar payments where there is a sufficient connection between the two legs of the back-to-back arrangement. This measure will apply to rents, royalties or similar payments made after 2016.
- Character substitution rules: Budget 2016 proposes to add character substitution rules pursuant to which a back-to-back arrangement will exist where the legal nature of the instrument under the Canadian leg of the arrangement is different from that of the instrument on the second leg of the agreement but a sufficient connection is established between the two arrangements. This measure will apply to interest and rent, royalty or similar payments made after 2016.
- Expansion of existing shareholder loan rules: Budget 2016 proposes to expand the scope of the existing shareholder loan rules to include back-to-back loan arrangements, such that a shareholder of a Canadian-resident corporation may have certain amounts included in its income (or be subject to Canadian withholding tax) where such shareholder owes amounts to an intermediary in the context of a back-to-back loan arrangement. This measure will apply to back-to-back shareholder loan arrangements as of March 22, 2016.
- Multiple Intermediary structures: Budget 2016 proposes to clarify the application of existing back-to-back rules and the proposed back-to-back rules for royalty payments to back-to-back arrangements involving multiple intermediaries. This measure will apply to interest and rent, royalty or similar payments made after 2016 and to shareholder debts as of January 1, 2017.
C. Significant personal tax measures
Taxation of Employee Stock Options
Changes to the taxation of employee stock options had been anticipated since the election of the new government. The Liberal party platform proposed to limit the favourable tax treatment afforded to stock option benefits, which created significant concern among the business community. Budget 2016, however, did not provide any mention of stock options. Comments from the Minister of Finance indicate that the government has no current plans of changing the tax treatment of stock options.
Taxation of Switch Shares
Mutual fund and investment corporations can issue multiple classes of shares. Some corporations are structured so that each share class tracks a fund that comprises a specific pool of assets. The existing “rollover” rules in the Act allow an investor in one class of shares to switch to another class that tracks a different fund without recognizing accrued gains on the original investment. Budget 2016 proposes to treat an exchange of shares that track different funds to be a disposition at fair market value for dispositions that occur after September 2016.
The proposed measure will not apply to switches where the shares received in exchange differ only in respect of management fees or expenses to be borne by investors and otherwise derive their value from the same portfolio or fund within the mutual fund corporation (e.g., the switch is between different series of shares within the same class).
Sales of Linked Notes
Linked notes are a type of investment whereby a taxpayer is entitled to a return on its original investment that is contingent on the performance of a reference asset such as a basket of stocks, a market index, a commodity, a currency, or units of a fund. Investors often take the position that the accrued return on the linked note is not taxable until maturity. Investors who treat the notes on capital account can, by selling before maturity, convert their accrued but unrealized return from fully taxed income to a capital gain taxed at 50%.
Budget 2016 proposes rules that will treat the accrued but unrealized increase in value on a linked note to be accrued interest that will be included in income at the time of disposition. Any gain or loss on the debt obligation due to foreign exchange fluctuations will be excluded in determining the amount of accrued interest. If a portion of the return on a linked note is based on a fixed rate of interest, Budget 2016 proposes to exclude any portion of the gain that is reasonably attributable to market interest rate fluctuations.
Mineral Exploration Tax Credit
Budget 2016 proposes to further extend the 15% Mineral Exploration Tax Credit to flow-through share agreements entered into on or before March 31, 2017 (from March 31, 2016). This credit is intended to help junior mineral exploration companies raise capital by providing an incentive to individual investors in flow-through shares issued to finance “grassroots” mineral exploration.
Registered Labour-Sponsored Venture Capital Corporations
Budget 2016 proposes to restore the 15% tax credit for share purchases of provincially registered labour-sponsored venture capital corporations prescribed under the Act for the 2016 and subsequent taxation years.